If You Put Down Less Than 20%, You’re Paying Mortgage Insurance

Here’s yet another anecdote involving some buddies who were arguing about their mortgages. This seems to be a trend lately.

In short, both guys put less than 20% down on their respective home purchases, but one argued that he didn’t have mortgage insurance, while the other said that’s impossible.

Essentially, the answer lies in how private mortgage insurance is presented to the borrower.

Several Ways to Pay PMI

Lenders often advertise no PMI on home loans as a benefit

But if your LTV is above 80% (less than 20% down)

It is being paid whether you realize it or not

Perhaps indirectly via a higher mortgage rate

There are a variety of ways to pay PMI, with some more obvious than others. And some so not obvious that it may appear that you’re not even paying PMI.

For example, you can pay PMI monthly, a very common scenario where the borrower’s monthly payment consists of principal, interest, taxes, homeowners insurance, and mortgage insurance.

Basically, you pay some small (or large) amount each month to satisfy the mortgage insurance until you can get rid of it, usually around the time your loan reaches 78-80% LTV.

This is very obvious PMI in that the borrower sees it in their monthly payment, and their total housing payment is higher as a result. You’ll see this with the MIP on FHA loans as well.

There’s also lender-paid mortgage insurance, which is a lot less obvious, and even confusing given the name. Does the lender really pay it? Yes, they do, I guess. But you, the borrower, are the one actually footing the bill.

You see, the lender pays the premium on your behalf, but you wind up with a “slightly higher interest rate.” In other words, it’s not lender-paid, it’s indirectly borrower paid through a higher mortgage payment.

Depending on how the loan officer or mortgage broker presents this, it may appear that the borrower “doesn’t have to pay PMI,” or doesn’t have mortgage insurance on their loan.

I guess you could spin it that way and get away with it, but it’s a little disingenuous. In reality, the borrower may have received a rate of 3.75% instead of 4.25% if they had just put down 20% to begin with.

Another method of paying MI is via an upfront premium, which again can be paid by the bank via a lender credit at closing.

In this scenario, the lender again charges a higher rate of interest in exchange for some money at closing. That money can be used to pay closing costs, such as a lump sum one-time payment for mortgage insurance.

It May Feel Like You Didn’t Pay for It

I’ve had friends tell me they didn’t have to pay MI

Despite only putting down 5-10% on a home purchase

This just means they got stuck with a higher interest rate to cover it

Which is fine as long as the rate is competitive and doesn’t cost them more of the life of the loan

A borrower who isn’t paying much attention might tell their friends they don’t have/pay mortgage insurance because it was paid upfront at closing and isn’t in their monthly payment.

Oh, and they didn’t pay for it out-of-pocket because the premium was covered by that lender credit. To this borrower, they may feel superior to the borrower making the monthly MI payment. I think this is what my friend was arguing to his buddy.

In reality, both guys are paying mortgage insurance, just in different ways. What’s interesting is how they perceive it though. The guy who “doesn’t have MI” was sold a loan on that pretense, though he did go with a lender that offered a lower interest rate, so I suppose it worked out.

Here’s the problem though…the guy that thinks he didn’t pay MI actually paid for it in full. So if he refinances anytime soon he’ll lose out on the coverage because it was prepaid upfront.

The other guy has a monthly MI payment and didn’t prepay for the entire thing. So if he refinances early, which he actually wound up doing, he avoided paying the bulk of the MI because the loan was only a couple years old.

The moral of the story is first to know that you are indeed paying for MI if you put less than 20% down on a home purchase, even if there’s “no MI,” and the way you pay for it could cost you if you sell/refinance sooner than expected.